Looking at the May Swoon

The stock market just finished its worst May since 1940. As it turns out, watching France fall to the Nazis isn’t good for stocks here. Also, watching the euro fall to reality is pretty nasty as well.
Let’s take a closer look at where the market stands today. Here’s the S&P 500 (black line, left scale) along with its earnings (gold line, right scale).

I’ve scaled the two lines at a ratio of 16 to 1 so whenever the lines cross, the market’s P/E Ratio is exactly 16.
Let me add that looking at the market’s P/E Ratio is far from perfect (the future earnings line is, of course, merely forecast), but nevertheless we can gain some insights as to what investors are thinking at the moment.
Two items stand out. The first is that the S&P 500 has fallen below a P/E Ratio of 16 which has generally been its lower bound over the past few years. The second is that the earnings forecast is still very favorable. If stocks keep pace with valuations, then the S&P 500 could easily be over 1400 within 18 months.
This is where the problems come in. It appears that investors are beginning to question the robustness of the recovery. Given the amount of aid needed, that’s certainly understandable. So if the earnings forecast turns out to be overly optimistic, then the whole bullish scenario falls apart.
My feeling is that the bearish cause has been pushed a bit too. Consider that many companies are still maintaining decent guidance. Even the bad guidance isn’t that bad. On Friday, shares of J.C. Penney (JCP) got knocked due to “poor guidance.” I’d agree that JCP is a weak buy right now, but they merely said to expect full-year EPS of $1.64 which was one penny below the Street.
I used JCP as one example, but if the future yellow line is off, then we’re going to have to see much more lower guidance announcements. That simply hasn’t come yet.
This week, we’ll get some news on our Buy List stock, Jos. A Bank Clothiers (JOSB). This company hasn’t missed an earnings forecast in four years. They haven’t given guidance for this year but they have said that they plan to open 30 to 40 new stores. Wall Street expects 71 cents per share which is a nice increase over the 62 cents per share from a year ago. My numbers say it will be close to 75 cents a share.
JOSB is a solid buy. We’ll know more on Thursday (correction: Tuesday) when the earnings report comes out.

Posted by Eddy Elfenbein on June 1st, 2010 at 10:26 am

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.